Merits of Foreign Direct Investment (FDI)

Several advantages can be claimed for foreign direct investment (FDI):

(1) Such investment does not burden the tax payer since no interest at fixed rate is to be paid as in the case of foreign borrowing. The foreign investor is compensated by the profit he gets.

(2) In private investment, the investor is actuated by the profit motive; hence the business operations are subjected to careful calculations. This is a guarantee that the capital resources are most efficiently employed and are not frittered away in some reckless investment as may happen in the case of borrowing.

(3) Direct investment by foreign companies introduces, in the developing country, new technology, modern skills, innovations and new ideas. This is a great gain because the developing country is backward in technology and skills. The local entrepreneurs take a clue and start similar concerns. The Indian cotton textile industry was inspired by the Indian jute industry established by British entrepreneurs. Thus, direct foreign investment serves as an instrument for transferring modern technology to the developing countries.

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(4) Another advantage is that a part of the profit is ploughed back into business and is not drained off from the country as it happens in the case of portfolio investment. The profits are invested either in modernisation and expansion of existing concerns or for establishing ancillary or subsidiary concerns in related fields. There is thus a continuing advantage for the developing country.

(5) Foreign direct investments are most likely to flow into export industries. By increasing exports and reducing imports, it will improve balance of payments of the developing country. It has a specially favourable effect on balance of payments position during recession because direct investment is serviced by dividends which are related to profits and not by fixed interest charges as in the case of loans. This flexibility of pressure on the balance of payments is of great advantage.

(6) Even otherwise flexible return on direct investment is a great advantage as compared with rigid interest and amortization requirements associated with public foreign loans.

(7) Direct foreign investment induces domestic investment also either in the form of joint participation or in local ancillary industries. Thus, foreign capital activates otherwise inert domestic capital. The domestic capital sheds off its shyness and enters into fields opened by direct foreign investment.

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(8) The direct foreign investment makes a real addition to the productive capacity of the capital importing country. There is no question of foreign capital coming in this form being used for unproductive purposes. In the case of other types of foreign borrowings, there is nothing to prevent them from being utilised unproductively.

(9) Another important advantage of direct foreign capital is that it can be induced to be invested in infrastructure such as power, telecom, and development of ports which is an obstacle to accelerating economic growth in the developing countries. Such direct foreign investment enables the developing countries to overcome supply-side bottlenecks which will spur domestic invest­ment. It should be mentioned that in recent times the Indian Government has been wooing foreign investors to invest in the infrastructure sector. The foreign companies have the resources, technology and technical knowhow to start productive ventures in the infrastructure.

(10) The capital that comes through foreign direct investment has a distinct advantage over portfolio investment. While foreign institutional investors can sell their shares and take capital out of the developing countries in a very short time and thus destabilise these economies as recently happened during East Asia Crisis, it is not easy to close down foreign concerns established through direct investments. Foreign Direct Investment (FDI) enters the developing economics to build factories and these factories (i.e., physical capital) stay even if the investors decide to sell out later to domestic buyers.

The direct foreign investment (DFI) is opposed on the ground that it seeks to establish ‘financial imperialism’. It leads to political domination and economic exploitation. That is why foreign capital was so unpopular in India. The strength of this objection really rests on the nature of political set up. A free democratic country of the continental size such as India need not entertain such fears.

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In order to promote private foreign direct investment, it is necessary both for the lending and borrowing countries to remove the impediments to free flow of capital and to grant the necessary facilities. The borrowing country should guarantee immunity from nationalisation and repatriation of profits.

The crux of the problem is to assure higher returns and minimum risk. At present investment is deterred by political and social instability, uncertainty about the jurisdiction of courts, exchange controls and currency inconvertibility, controls on capital issues, fear of discrimi­natory legislation and fear of nationalisation, the practice of shutting out some industrial fields for foreign investors, employment of nationals in superior posts etc.

Among the measures to minimise risks and allay fears may be mentioned investment treaties, government guarantees, tax incentives, joint ventures, relaxation of restrictions and granting of concessions.

In short, the investment climate must be made most favourable by ensuring the following:

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(i) Political stability and freedom from external aggression.

(ii) Security of life and property.

(iii) Availability of opportunities for earning profits.

(iv) Prompt payment for fair compensation and its remittance to the country of origin in the event of compulsory acquisition of a foreign enterprise.

(v) Facilities for the remittance of profits, dividends, interest, etc.

(vi) Facilities for the immigration and employment of foreign technical and administrative personnel.

(vii) A system of taxation that does not impose an excess burden on private foreign enterprise.

(viii) Freedom from double taxation.

(ix) A general spirit of friendliness for foreign investors.

The department of commerce of the United States mentions certain factors which stand in the way of private investment of American capital are uncertainty created by the present political situation, the policies and practices with respect to foreign investment, the relatively low level of economic infrastructure and the lack of trained labour, and the limited knowledge of the developing countries on the part of American businessmen.

The particular impediments mentioned in the case of India are the nature of India’s screening policy shutting out foreign investment in certain spheres and controls on imports, exports and foreign exchange and the absence of a double taxation agreement, obligation to employ and train Indian labour.

India also offers some special inducements, e.g., special tax exemptions, increased depreciation allowance and other benefits available to-domestic industry, guarantee of exchange facilities for profit remittances, capital repatriation and import of essential requirements, government assistance in the acquisition of land, transport facilities, etc., the right to hold controlling interest.

This compares quite favourably with many other countries. But there are still some countries with more attraction in the form of higher returns and better guarantees and they can absorb a substantial supply of foreign U.S. capital.

However, in the opinion of the present author direct foreign investment in the field of infrastructure in India may not be as much as expected because infrastructure projects relating to power, telecom, ports are of the nature of public utilities and therefore, the price of their end- product (for example, electricity charges) have to be controlled which may not yield sufficient profits to attract foreign investment.

However, it may be noted that inflows of foreign direct investment in India have been very low as compared to those occurred in China. If the Enron power generation project is scrapped by the Government, fresh inflows of foreign direct investment are expected to suffer a sharp setback.

Some of the other state governments are also reviewing their earlier decisions permitting multinationals to set up huge power plants. If some more projects are scrapped, the net inflow of foreign direct investment would slow down. The flow of direct foreign investment is largely linked to the political climate.

Several international observers have opined that a developing country like India should try to attract much larger direct foreign investments rather than encourage portfolio investments. Sir William Ryrie, former chairman of the International Finance Corporation, who has for decades closely watched developments in several developing countries, including India, says that portfolio investments do not result directly in “real” investment in the economy, though they do help “free” resources which can be used for real investment. Portfolio capital inflows can be volatile and cause problems when confidence weakens and funds are withdrawn. The recent Mexico and South East- Asian countries experience has shown how a country can be driven to a crisis when foreigners resort to a massive withdrawal of funds.

India has the basic ingredients to attract much larger foreign direct investments. Its vast domestic market, a low cost production base, along with the availability of skilled labour, adequate repatriation facilities and a good legal system have placed the country ahead of several others for foreign investors.

If these favourable features are reinforced by a stable political environment, the country should be able to attract larger direct inflows of funds. China attracted over $ 30 billion of direct foreign investment during four years (1991-95) accounting for over a third of the total funds earmarked for the Asia-Pacific region.

On the other hand, India has clearly emerged as a better market for foreign portfolio investment. Most fund managers rate India above China, the Philippines, South Korea and Indonesia among Asian markets. India is also rated higher than some of the Latin American markets like Colombia and Peru and European markets like Greece and Hungary.